A Quick Look at the Tax Proposals in the Democratic Budget Plan

While much of the attention about taxes in the budget-balancing plan presented by Democrats on June 18 has focused on creation of an oil severance tax and boosting the tax on a pack of cigarettes to $1.50, there are 11 other tax increases, accelerations and changes.

The biggest – compared to the estimated $1.1 billion the severance tax will yield and the $1 billion the cigarette tax generates – is a repeal of actions taken in the February budget that would allow businesses to use net operating losses that occur after January 2011 to offset earnings during 2009 and 2010, the two-year period the February budget suspends use of the net operating loss tax break.

The Democrats’ plan would also eliminate the ability of a corporation to assign unused tax credits to an affiliate company.

The change saves the state $80 million in the fiscal year, which begins July 1, increasing to $850 million in 2014.

Quarterly estimated corporate tax payments – already accelerated in the February budget are accelerated even more under the Democratic plan, an idea first presented in the governor’s revised budget in May.

Instead of making four equal quarterly payments of 25 percent, businesses now pay 30 percent in April and June and 20 percent in September and December. The Democratic plan would boost the June payment, starting in 2010, to 40 percent. The September payment would be eliminated and 30 percent would be paid in December.

Another tax increase proposed by the governor and adopted by Democrats is a 4.8 percent surcharge on property insurance to raise $120 million to cover the costs of state emergency response, particularly fire-fighting in unincorporated, largely rural areas.

Payroll withholding would be increased by 10 percent, starting in January 2010 – another proposal by the GOP governor – to collect $1.7 billion in income tax revenue sooner.

Another acceleration move requires businesses and the public sector to withhold 3 percent of any payments to independent contractors. The change brings in nearly $2 billion for the fiscal year starting July 1, falling off to $130 million the following year.

Out-of-state sellers that pay commissions to California firms or residents for sales referrals – the budget conference committee cites Amazon as an example – would collect sales tax on purchases by California residents. That would yield $110 million annually.

Businesses that provide services – non-retailers – would file use tax returns with the Board of Equalization. Use tax returns apply to purchases in which no sales tax was collected – generally from out-of-state sellers, the committee says. A revenue gain of $28 million in the upcoming fiscal year and $57 million the following year, according to the committee’s figures.

A broader definition of what constitutes an “abusive tax shelter” would boost annual state revenue by $10 million to $15 million.

Delinquent taxpayers could have their licenses revoked. Suspension could be avoided by entering into an installment payment plan with the Franchise Tax Board. Yields $10 million in the upcoming fiscal year and up to $20 million thereafter.

Banks and other financial institutions would be required to conduct quarterly matches of their account records with the file of tax delinquents. The idea is to more swiftly identify assets that can be used by the Franchise Tax Board to pay down delinquent tax debts. An estimated $27 million would be raised in the next fiscal year, $60 million the following year and $100 million in subsequent years, according to the committee.

And businesses ordered by the Internal Revenue Service to report non-wage payments such as interest, dividends and compensation for services – would need to withhold 7 percent of those payments.

The conference notes that the provisions of many of these proposals are contained in other bills, several of which failed to win passage in the Legislature’s normal committee hearing process.

“Out-of-state sellers that pay commissions to California firms or residents for sales referrals – the budget conference committee cites Amazon as an example – would collect sales tax on purchases by California residents. That would yield $110 million annually.”

In regards to this portion of the budget-balancing plan, there is a concerted effort to oppose this by the affiliate community. The nexus language that is included in the plan tries to redefine “physical presence” from the definition in Quill v. N.Dakota to include the advertising relationship between local website owners (known as affiliates or publishers) and out of state merchants, regardless of size. The merchant most often mentioned with this is Amazon, but it affects all out of state merchants.

Regardless of the unconstitutionality that could be argued on this redefinition of nexus, the main problem here is the basic math. As it stands now, very few people pay the use tax that is already legally due on out of state purchases nor do most know that they are actually required to do so. The state needs money and in looking for a simpler way to enforce collection, wants the out of state merchants to do it rather than the consumer. They believe that this will garner $110 million annually, however the relationship between affiliate advertisers and out of state merchants is an at will relationship that can be severed instantly by either party. This means that if the merchant doesn’t want to deal with the technical implementation of collecting the tax or the manpower needed to remit it properly, all they have to do to be exempt from the law is remove California affiliates from their program. No California affiliates, no tax collection, no headache for the merchant. This equates to a loss of income tax revenue from the more than 30,000 affiliate advertisers residing in California, little or no additional revenue from collected sales tax by out of state merchants and the destruction of small businesses statewide.

When a similar law was passed last year in New York, hundreds of merchants took this road and removed New York affiliate advertisers from their programs. This resulted in a 50% loss in income to those advertisers, but little or no net loss to the merchants as they simply replaced those removed advertisers with advertisers in other states. The threat by merchants to do the same here if a similar law is passed is very real and needs to be taken seriously. Amazon just yesterday stated their intent to remove California affiliate advertisers if this is enacted and other merchants will certainly follow suit.